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Summary

Summary. Paper a collaboration of: the Stanford Center on Longevity, and the Society of Actuaries’ Committee on Post-Retirement Needs and Risks (CPRNR) Authored by Steve Vernon, Research Scholar at the Stanford Center on Longevity. svernon@stanford.edu

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Summary

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  1. Summary • Paper a collaboration of: • the Stanford Center on Longevity, and • the Society of Actuaries’ Committee on Post-Retirement Needs and Risks (CPRNR) • Authored by Steve Vernon, Research Scholar at the Stanford Center on Longevity. svernon@stanford.edu • Stochastic forecasts by Dr. Wade Pfau, professor of retirement income at The American College • Fiduciary discussion by Fred Reish, Bruce Ashton, and Joshua Waldbeser at Drinker Biddle & Reath LLP • CPRNR formed a Project Oversight Committee chaired by Sandy Mackenzie • Published September 2013

  2. Today’s Agenda • Summary of retirement planning environment • Review of current and future trends at employer-sponsored DC plans, including retirement income • Summary of methods to generate retirement income from savings • Analysis of retirement income generators (RIGs) • Features – pros and cons • Projections of amount of retirement income at retirement and beyond • Projections of remaining wealth • Stay in employer plan or IRA rollover? Pros and cons • Putting it all together: Retirement income strategies • VII. Next phases of analysis

  3. I. Retirement Planning Environment • Risks facing retirees • Quantifiable risks • Market/sequence of returns • Longevity • Withdrawal rates too high • Inflation • High fees • Insurer insolvency • Liquidity • Inadequate protection for surviving spouse • Behavioral risks • Inadequate understanding of issues with generating income • Temptation to spend more today • Mistakes, fraud, or cognitive decline • Poor/biased advice • Inability to assess and self-execute

  4. I. Retirement Planning Environment • Decisions on retirement income made in following context • Social Security claiming • Existence of traditional pensions • Deploying home equity • Role of continued work • Threat of high expenses for medical or long-term care • Desire to leave a legacy • Expected pattern of living expenses • Amount of debt • Level of income taxes

  5. II. Review Trends Employer-Sponsored DC Plans • Retirement Income Options Not Yet Widespread in Employer-Sponsored DC Retirement Plans From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  6. II. Review Trends Employer-Sponsored DC Plans • Interest Heating Up with Retirement Income Solutions in Employer-Sponsored DC Retirement Plans • Accounts in 401(k)/DC plans significant part of boomers’ retirement resources • Employers expressing no interest in retirement income solutions in AonHewitt survey dropped from 57% to 27% between 2012 and 2013 • In 2009 DOL promulgated safe harbor regulations on annuities in DC plans • DOL considering regulations on longevity annuities, retirement income statements in DC plans • Recent papers on retirement income from professional groups: • Society of Actuaries: The Next Evolution in DC Retirement Income Design • American Academy of Actuaries: Risky Business – Living Longer Without Income for Life

  7. II. Review Trends Employer-Sponsored DC Plans • DC Plan Investment Menu Design • at Sophisticated Employers • Passive funds, drive fees as low as possible • Limited menu of core index funds in domestic, small cap and international stocks, bonds, REITs • Target date funds that package the core index funds • Employees can elect target date funds or mix their own asset allocation

  8. II. Review Trends Employer-Sponsored DC Plans • Academic Research Shows Underperformance of Actively Managed Portfolios

  9. II. Review Trends Employer-Sponsored DC Plans • Emphasis on Transparency and Disclosure

  10. II. Review Trends Employer-Sponsored DC Plans • Fiduciary Issues • ERISA defines prudent man rule for all fiduciary decisions, including selection of retirement income generators in DC plans • Emphasis on reasonable and documented process, not on outcomes • Safe harbor rules go beyond general prudent man rule; exist for: • Selecting annuities in DC plans • Advice provided in DC plans • Default retirement income option significant fiduciary decision • No regulatory guidance on default design • De facto default: QDIA combined with IRS RMD

  11. III. Three Types of • Retirement Income Generators (RIGs) Investment income: Invest savings, spend investment income, leave principal intact Systematic withdrawals: Invest savings, withdraw principal cautiously to avoid outliving principal (but no guarantee) Annuity: Purchase guaranteed lifetime income from insurance company Many possible variations and combinations with each approach

  12. III. Variations on • Retirement Income Generators (RIGs)

  13. III. Features of RIGs in DC Plans • In-plan vs. out-of-plan • Products vs. advice vs. guidance • At retirement vs. leading up to retirement

  14. III. Retirement Income Generators (RIGs) • Sample of Current Providers

  15. IV. Analysis of RIGs • Evaluation Criteria for RIGs in DC Plans • Amount of income • Lifetime guarantee • Pre-retirement protection • Post-retirement potential for increases • Post-retirement protection • Access to savings • Inheritance potential • Investment control • Withdrawal control

  16. IV. Analysis of RIGs • Evaluation Criteria for RIGs in DC Plans From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  17. IV. Analysis of RIGs • Projections of Retirement Income • Stochastic forecasts of: • Systematic withdrawals – constant amount 4% rule • Systematic withdrawals – constant percentage 4% of assets • Systematic withdrawals – IRS RMD • SPIA – inflation adjusted • SPIA – fixed • GMWB • Assumptions • Systematic withdrawals and GMWB assume 60/40 equity/bond allocation • Institutional pricing • Assumptions on inflation, investment returns and annuity pricing reflect current low-interest environment • See Appendix for details • Forecasts prepared by Dr. Wade Pfau, professor of retirement income at The American College

  18. IV. Analysis of RIGs • Projections of Retirement Income Real retirement incomes – expected scenario 50th percentile Flat line keeps pace with inflation From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  19. IV. Analysis of RIGs • Projections of Retirement Income Real retirement incomes – unfavorable scenario10th percentile Flat line keeps pace with inflation Annuities Systematic withdrawals From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  20. IV. Analysis of RIGs • Projections of Retirement Income Real retirement incomes – favorable scenario90th percentile Flat line keeps pace with inflation Systematic withdrawals Annuities From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  21. IV. Analysis of RIGs • Projections of Retirement Income Real retirement incomes – favorable scenario90th percentile Flat line keeps pace with inflation From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  22. IV. Analysis of RIGs • Projections of Remaining Wealth Expected scenario - 50th percentile From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  23. IV. Analysis of RIGs • Projections of Remaining Wealth Unfavorable scenario – 10th percentile From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  24. IV. Analysis of RIGs • Projections of Remaining Wealth Favorable scenario – 10th percentile From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  25. IV. Analysis of RIGs • Projections of Retirement Income 50/50 combination of inflation-adjusted SPIA, SWP-RMD 90th percentile 50th percentile 10th percentile From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  26. IV. Analysis of RIGs • Projections of Remaining Wealth 50/50 combination of inflation-adjusted SPIA, SWP-RMD 90th percentile 50th percentile 10th percentile From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  27. V. Stay in Employer Plan vs. IRA Rollover? • Pros and Cons • Large employers may negotiate fees and performance not available on retail basis • Examples: • Equity index fund with 2 bps • Stable value fund earning 3%/year, full liquidity • SPIA transaction fees of 2% with competitive bidding • GMWBs with insurance and investment fees totaling 150 to 200 bps • On the other hand, small employers may have 401(k) funds with 150 bps or higher

  28. V. Stay in Employer Plan vs. IRA Rollover? • Institutional vs. Retail Pricing • Institutional pricing can make a difference • SPIAs: competitive bidding platform has potential to increase retirement incomes by 10% to 20% • GMWBs: institutional pricing can produce retirement incomes 12-1/2% to 20% higher than retail • SWPs: 50 bps vs. 150 bps • Constant percent and RMD can result in retirement incomes 10% higher after 10 years, 21% higher after 20 • Four percent rule: savings exhausted 2-3 years earlier From Society of Actuaries’ report: The Next Evolution in Defined Contribution Retirement Plan Design

  29. VI. Putting It All Together • Retirement Income Strategies • Solutions combining SWPs and annuities strategies may produce reasonable compromise • For example, cover nondiscretionary expenses by guaranteed sources of lifetime income: Social Security, pension, annuity • Cover discretionary expenses with SWP strategy • May justify higher withdrawal rate and/or aggressive asset allocation • Subject of next phase of analyses by Stanford Center on Longevity

  30. VI. Putting It All Together • Retirement Income Strategies • Use DC assets to enable delaying Social Security to age 70 • Increase in Social Security income can be viewed as “annuity purchase” at a rate far more favorable than open market • Analysis by Dr. John Shoven, director Stanford Institute for Economics Policy Research • To enable, set up SWP program to replace SS benefits that are being delayed, up to 8 years from age 62 to 70

  31. VI. Putting It All Together • Retirement Income Strategies RIG ComparisonsHow much annual income does $100,000 buy?Age 65 Retirement • Notes: • Amounts shown are for single life annuities. • Comparisons similar for joint and survivor annuities. Lump sum from employer-sponsored defined benefit plan may not be best choice

  32. VII. Next Phases of Analysis • Examine strategies combining SWPs and SPIAs using efficient frontier analysis • Does delaying Social Security extend efficient frontier? • Practical considerations with combining SWPs and longevity annuities • How can retirement income be protected in period leading up to retirement? • Fixed deferred annuities • GMWB annuities • Target date funds • Behavioral finance considerations the next frontier in plan design

  33. DISCUSSION and QUESTIONS

  34. Appendix: Assumptions for Stochastic Forecasts • Institutional Pricing • Annuity purchase rates as percent of assets: • 5.49% fixed SPIA • 3.57% inflation-adjusted SPIA • 4.50% GMWB • For 100% J&S, both age 65 • SWP investment expenses: 50 bps • GMWB investment and insurance expenses: 150 bps

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